Greetings. Welcome to the Lovesac third quarter fiscal 2020 earnings conference call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star, zero from your telephone keypad. Please note this conference is being recorded. At this time, I’ll turn the conference over to Rachel Schacter. Rachel, you may now begin.

Thank you. Good morning everyone. With me on the call is Shawn Nelson, Chief Executive Officer; Jack Krause, President and Chief Operating Officer, and Donna Dellomo, Chief Financial Officer. Before we get started, I would like to remind you that some of the information discussed will include forward-looking statements regarding future events and our future financial performance. These include statements about our future expectations, financial projections, and our plans and prospects. Actual results may differ materially from those set forth in such statements. For a discussion of these risks and uncertainties, you should review the company’s filings with the SEC, which includes today’s press release. You should not rely on our forward-looking statements as predictions of future events. All forward-looking statements that we make on this call are based on assumptions and beliefs as of today and we undertake no obligation to update them except as required by applicable law. Our discussion today will include non-GAAP financial measures, including EBITDA and adjusted EBITDA. These non-GAAP measures should be considered in addition to and not as a substitute for or in isolation from our GAAP measures. A reconciliation of the most directly comparable GAAP financial measures to such non-GAAP financial measures has been provided as supplemental financial information in our press release. Now I’d like to turn the call over to Shawn Nelson, Chief Executive Officer of The Lovesac Company.

Thanks Rachel. Good morning everybody and thanks for joining us today at Lovesac. I will begin today’s call by discussing our third quarter results, after which I’ll briefly review our high level thoughts around our outlook and provide a quick update on our recent new product introductions. Then Jack Krause, our President and COO will outline the progress we are making toward our key growth initiatives, including results around our amplified marketing programs and shop-in-shop programs. Finally, Donna Dellomo, our CFO will review our financial results and a few key items related to our outlook in more detail. We are pleased with our third quarter results and some key learnings we have recently gained on the marketing front that give us great confidence in our ability to generate strong sales growth in the pivotal fourth quarter and beyond, which Jack will expand upon later. Third quarter fiscal 2020 performance includes net sales growth of 25% and total comparable sales growth of 32.5%. This growth was driven by increases in new customers as well as increases in average order value, or AOV. Our recent new product introductions, including the Sactionals Power Hub and Storage Seats have exhibited approximately 45% attachment rates to date and have lifted the blended AOV of all Sactionals purchases, new and repeat, significantly. We continue to make good progress on all strategic priorities, including supply chain optimization, sourcing, growth of the pop-up shop business, and the successful launch of four permanent shop-in-shop locations within Macy’s stores intended to be a test toward a larger program. Our better than expected third quarter adjusted EBITDA results, in spite of experiencing slight top line impact from a timing shift to some new showroom openings demonstrates our disciplined approach to the management of this business even while achieving continued high growth.…

Thank you Shawn, and good morning everyone. As you know, marketing is a critical pillar of our growth strategy given that our brand is still in its infancy and we are investing to increase brand awareness and drive sales. We continue to test and learn with our marketing, pushing the envelope, being innovative with campaigns, channels and cadence. As we mentioned on our last call, we had planned to moderate our market spend in Q3 and we expected an associated sales deceleration. For the quarter overall, we saw sales growth of 25% and our comp sales growth was strong at 32.5%. As a reminder, we were up against a difficult comparison last year with the launch of our very first Labor Day national media campaign, so on a two-year basis our Q3 comp growth accelerated from Q2 and was the strongest that it’s been year to date. As we look ahead to Q4, we have incorporated marketing learnings in our marketing beyond the traditional furniture buying events and are pleased with the results of the Q4 revenue growth of over 42% quarter to date, as Shawn mentioned earlier. While we continue to be strategic in terms of timing of our marketing spend and concentrating it in periods where we maximize ROIs, especially during the peak holiday periods, we’ll also aggressively expand our marketing efforts outside of these periods where we see more opportunity to drive brand awareness. We will continue to look at new efficient marketing strategies to drive the business, and many of the marketing initiatives we have successfully tested so far this year will be leveraged heavily in the fourth quarter. You’ll see this in Q4 as we expand our awareness media outside of our historical patterns and heavy-up digital during key periods in order to strengthen conversion.…

Thank you Jack. Good morning everyone. I will begin my remarks with a review of our third quarter results and then provide some commentary around our thoughts for fiscal 2020. Net sales increased 25% to $52.1 million from $41.7 million in the prior year quarter. This sales growth was driven by strong showroom, internet, pop-up shop performance as well as new shop-in-shop test locations. We saw growth in transactions as well as ticket, resulting from successful digital marketing strategies which drew new customers to the brand while also driving repeat purchase behavior. An increase in the number of showrooms also helped fuel our Q3 sales performance. Total comparable sales, which include showroom and internet sales, increased 32.5%. Comparable showroom sales increased 27.1% and represents our 12th consecutive quarter of positive comp showroom sales increases. We opened four new showrooms, which is 9% year-over-year growth, and ended the quarter with 84 showrooms. As Jack mentioned, we are on plan to open 17 showrooms for the year with seven showroom openings falling in the fourth quarter. Looking at our results by channel for the third quarter, showroom sales increased 15.8% to $32.5 million, internet sales increased 47.7% to $11.4 million, and our other channel sales, which includes our pop-up shops in Costco locations and shop-in-shops in four Macys test locations, increased $2.3 million to $8.2 million for the quarter. By product category, our Sactional sales increased 26.3%, our Sacs sales increased 17.9%, and our other category sales, which includes decorative pillows, blankets, and other accessories increased 25.7%. Gross profit dollars increased 14.7% to $26.3 million in the third quarter. As expected, gross margin percentage decreased by 450 basis points to 50.4% from 54.9% reported in the same period last year. This year-over-year decline was primarily driven by the 25% tariff impact partially…

[Operator instructions] Our first question is from the line of Brian Nagel with Oppenheimer. Please proceed with your question.

Hi, good morning. Thank you for taking my questions. The first question I want to ask, just with regard to sales growth, and I know there’s a lot of moving pieces here, but in the fiscal third quarter as you discussed, the 25% sales growth, so that was down from something in the mid-40s in the second quarter, and then so far in the fourth quarter it’s popped -- sales growth has improved back to 40%. So could you help me understand better just the rank order of factors that sort of say created that divot, if you will, in sales growth in the third quarter? Are you recognizing that the comparison got more difficult?

Yes, this is Jack. I’ll handle that. I think one of the key insights to look at that is if you look at something we haven’t seen in a couple of quarters based on cadence, is the fact that our overall comps, for example in showrooms, were greater than our showroom growth, so basically we had a pull-back lever on non-comp perspective of the business versus a year ago, and that really is tied to those showrooms that shifted back – approximately, you know we had seven showrooms that shifted between the third and fourth quarter in one shape or another.

Okay, so is there a way, Jack--not to push too hard at this, but could you look at your math and say if you didn’t have that shift in openings from Q3 to Q4, what Q3 sales growth would have looked like?

Donna, I don’t know if you want to take a stab at that, what we think the impact was, the one-time impact?

I can, but let me also note that we were originally predicting to be--our growth in the third quarter to be a little less than it was in the second quarter due to the things that Jack mentioned and also the growth of the pop-up shop business year over year. If you go back to what we had said in the second quarter call, on the second quarter call again we had predicted to take a dip in the third quarter relative to that as well. We’re anniversarying the media, the growth in our shop-in-shops, our pop-up shops year over year because we had significant growth last fiscal for a little lower in the third quarter of this year. The sales, we’re probably looking at that shift in sales for the new showrooms opening probably to be approximately $2 million, which -- because we weren’t able to open originally as planned in the third quarter, it’s probably about $2 million impact on the top line.

But it’s important, Brian, to say if you look at, again back to the two years, I’d like to look at two-year stacks, Q3 the two-year stack was the highest it’s been year to date at 83% and we expect Q4 to be the highest of the year, so we are going over tougher comparables, but two-year stacks are continuing to be very strong.

Got it, that’s helpful. Then another question with regard to sales, so you talked about the nice performance so far here in fiscal Q4, so as the calendar goes, we’re I guess, about halfway through the quarter, but just can you remind us where, given the lumpiness of the holidays in the fourth quarter, how much of Q4 business has probably been transacted so far?

Wow, on a week to week basis, that changes pretty quickly. Donna. I’m not sure if you have that? It’s probably--I’d say we still have a good at least 50% of the quarter to go. Is that correct, Donna?

Give me a second, I’m just going to check that.

Yes, I mean, I think one thing just to build on that while she’s looking at the number, is coming out, I think it’s really important to note that while we intentionally pulled back on the Labor Day marketing or media, really, because we saw an opportunity to really be a little bit more distinct between our awareness media into our conversion media. We think we’re in a really nice place, especially with the wackiness around the Q4 and the shifts, so just to be on media full time and then just aggressively go with conversion digital media at the classic furniture buying period, so it gives us a real opportunity to expand our awareness to basically an always-on basis.

Yes, and just to confirm, we are right at around 50% at this point of Q4, Q4’s volume.

Okay. I’ll ask one more and then I’ll leave it to someone else. Congratulations on you quickly shifting the supply chain. So, what I heard you say is that as far as the tariff impact, we probably just saw bottom. The impact, you said it better - the impact upon gross margin, we just saw it bottom. Is it still the assumption that as the supply chain initiatives take hold that Lovesac will essentially get back everything it lost in gross margin as a result of tariffs over the next several quarters or so?

I’ll cover that and then I’ll hand it to Donna and Shawn. As a large basis, we certainly-- we are the lowest level, I’d say, of margin and we’ll continue to leverage in our margin, but it’s also important to note that everything we gain from margin improvements won’t go back to building pure profitability in the short run because we have about 18 months where we’ve laid out a lot of infrastructure commitments, building showrooms, building a better WMS, etc., so while we will gain significantly at the margin level, we’ll leverage significantly in the next 18 months, we’re not going to aim to push 100% of that into EBITDA because we’re really just trying to build the base to the company being a billion-dollar company in the next couple years.

Yes, and I can--oh, go ahead, Shawn?

You go.

Okay. To Jack’s point, that’s definitely something to keep into consideration. As far as tariffs, just as a reminder, we do maintain 12 to 14 weeks of supply of inventory, so as we’re shifting out of China into Vietnam, we still do have inventory that’s been impacted by the tariffs that we’ll be selling through, so we’ll continue to see some impact, lesser and lesser and lesser impact, as we sell through that inventory, and there still will be a part of our inventory specifically related to fabrics that we’re working to move out of China, but there is still a--although the smaller part of our inventory we will still have a piece throughout this year that has a tariff impact, so we will still see some tariff impact, although significantly less than last year, but there will be initiatives next year related to supply chain and distribution that will impact the gross margin line, so we’re not expected to recoup 100% of the tariff impact. But we absolutely do expect to see our gross margin line start to accelerate next year and then the years going out.

Yes, just one last comment on that. I think the short answer to your question, Brian, is yes, we will see gross margins recover fully as we view it, but not overnight and not even in the next four quarters fully. It’s not the tariff issue alone, it’s our investments into supply chain that are happening and need to happen to really get this business as scalable as we’d like it to be, because we foresee high growth for a very long time. WE are investing heavily in that, it will just be a long protracted recovery over--I won’t give you a number of quarters, but more than four quarters. But we believe we have a direct path to absolutely get it back to where we’d like it to be on gross margin.

Appreciate all the color. Best of luck with the balance of the year. Thank you.

Our next question is from the line of Thomas Forte with DA Davidson. Please proceed with your question.

Great, thanks. I have two questions. First, I wanted to talk about your ability to opportunistically get higher quality real estate locations for your new showrooms in today’s retail environment. Anecdotally, in Fairfield County I’ve seen some new excellent locations in both Greenwich and Westport. Second, I’d like to give you the opportunity, given that I get a lot of questions on this, to talk about Macys. Macys as a retailer seems to have a number of challenges, but can you remind us why you think Macys is a great partner for your shop-in-shop efforts? Thanks.

Okay, I’ll just answer that in order. I think Tom, from the perspective of real estate, you’re absolutely right on, and I think one of the things that having a very balanced business approach in terms of being omnichannel, being digital, having showrooms allows us, and having a fair amount of marketing behind us, is giving us new choices, so you certainly have seen off-mall locations as well as lifestyle center locations pop up. We’ll continue to be significantly more diverse in the future as we look at our opportunities and we look at the investment in media relative to the investment in various levels of real estate as really shifts between customer acquisition approaches. Net-net, I think you’ll see us more in off-mall in the long run as we’ve seen the ability to open street locations very quickly based on our media, and that gives us a lot of power in terms of negotiation. I think we’ll see considerable diversity in the future as well as an ability to leverage our real estate costs. The second question was about Macys. Yes, so I think the one thing to think about Macys, they certainly have a lot of problems. It’s sort of like the end of the retail world and the retail apocalypse. Macys certainly has their own challenges, but they’re a pretty large company still and they have a very large percentage of the overall furniture market in the U.S. In fact, they’re one of the largest furniture retailers and they have a significant shared customer base that shares some of the values of ours, especially in some of their more premium locations, so I think we have a huge opportunity to learn where the biggest opportunities are, how their real estate works with ours, and how to leverage each other in order to create low capex, win-win, high brand awareness model. A lot of opportunities, it is a test, and as soon as we have more insights, we’ll keep you posted; but there’s a lot of people shopping at Macys and the company is going to be around for a while, and I think we’re going to try to see if we can leverage off of each other.

Thank you Jack.

Our next question is from the line of Maria Ripps with Canaccord Genuity. Please proceed with your question.

Good morning and thanks for taking my question. Could you share maybe any additional color around your commentary of greater than 42% revenue growth so far this quarter, given that your guidance implies 42% to 47% growth in Q4? Then I have a follow-up.

Donna, you want to start that, or--?

Yes, can you just repeat that one more time? I’m sorry.

Yes, I was just asking whether you could maybe share some additional color around your commentary of greater than 42% revenue growth so far in the quarter, because I think your guidance implies 42% to 47% growth range in Q4.

Well, we didn’t give Q4 guidance. Our guidance is saying 40% to 42% for the year. Does that make it clearer?

And Shawn did mention 42% quarter to date, which--so I think what we were trying to say is we don’t want to give guidance for the rest of the year, which it’s getting pretty close to giving it as we speak, but the bottom line is I think the point is, coming out of the Labor Day period and looking at our new marketing strategies that are not as based or focused as much on these big furniture events or these big sale events, such as Labor Day or Black Friday, has really allowed us to create a new baseline outside of those periods, which is giving us a 42% growth quarter to date and makes us feel confident about the business strategy going forward.

Right, and the only other thing we did say as far as for the fourth quarter, that we did feel that the fourth quarter would come in at or above the high end of the range of the 42%.

Yes, and we have said too that the fourth quarter stack comps would be the highest of the year.

Got it. Then maybe on your advertising efforts, as your brand awareness increases, are you seeing any changes in the type of buyers you’re attracting to the platform, either from a demographic standpoint or their stickiness with the platform? Also, how are you thinking about stronger brand awareness driving higher repeat rates over time?

Good question. What I’ll do is say we are seeing some things change, and I will probably defer most of that answer to our Q4 results as we talk about the overall view of the year for customer acquisition and look at the customer, but we’re certainly seeing a broadening of customer appeal across larger sets of age groups, so we do see--along with the young millennials, we’re seeing what we call the silver foxes coming in and buying at significantly higher levels as well, so we’re seeing really an expansion generationally in the interest, and I think that’s clearly directed based on the TV awareness campaigns that we’ve used in the last year or so. Then to follow up, what was your next question?

That was it, that was the follow-up question.

Okay.

You answered it, thank you so much.

Oh, and the AOV, I think you--yes, so we’re continuing--that’s a good point, because I did want to--. We’re continuing to see increased AOV and we’re very--I think we’re very positive on that, and it’s not through promotion. I think it’s really critical to say we’re going to see growth through repeat purchases through our new products. We’re already seeing a really nice attachment rate driven by both new customers and also our embedded customer group in terms of the storage seat and the Power Hub, and they will continue to grow in terms of impact on the business in the out years. We’re very excited about what we’re seeing in terms of the platform. Shawn’s discussion of the platform historically, that it’s not a product, it’s a platform and the benefits of it, we are clearly seeing that in the third quarter and we expect to see it going forward in terms of very high attachment rates and seeing immediate impacts on AOV with those customers trading up.

Yes, and I’ll add, Maria, because you had mentioned the notion of future business being driven by word of mouth and by the--you know, the context that’s easy to forget is that Lovesac has less than 2% brand awareness. Sactionals are a very unique invention that masquerades as a couch, but it’s quite unique in the landscape. There’s nothing like it. As Sactionals catch on someday beyond our forcing it through the funnel with advertising, as they become popular, the business has a tremendous opportunity to enjoy a tailwind that just comes from brand awareness that we don’t have yet, and we often overlook mentioning that because it’s impossible to plan, but it’s undeniable that the competitors who we sell couches against, many of them have significant brand awareness that drives those businesses with very little advertising. We will achieve that the further we expand this brand, and that’s just--it’s impossible to plan out, but that’s something we very much expect.

Yes, and I think to build on that, I think it’s funny - we are asked a lot of questions about increasing levels of marketing, etc, and how does that work in the long run, and I think one thing for everybody to keep in mind is because we have a strong showroom business as well as a D2C business outside of showrooms, we’re really in a fortunate position, so to put it in perspective, this year alone, even with the significant increases in TV advertising, our number one source of new customer acquisition is showrooms. That tells us two things: we have a long runway to acquire customers just with showroom growth; and number two, every time we open a showroom, we get a 2% increase in our ROI on marketing. There’s a real virtuous circle there that will continue to help us drive efficiency in marketing that probably isn’t as obvious externally right now, but we’ll see huge advantages in the next 24 months.

Great, thank you so much.

Our next question is from the line of Dave King with Roth Capital. Please proceed with your question.

Thanks, morning everyone. First on the 40%-plus growth implied for Q4, how much of that is transaction versus AOV growth, and then how much are you planning to grow marketing to get that revenue?

I can tell you a couple things. If you look at our--I’ll give you our year-over-year marketing [indiscernible] from the last three years. So year-over-year, ending last year, our marketing grew from $9 million to $18 million, so that was 100% year-over-year This year, we’re going from $18 million to $30 million, so it’s approximately a 60% growth year-over-year. We have growth that’s higher than--our marketing spend growth right now is at a higher rate than our total top line growth; however, as you can see from those numbers, the rate of increase is decreasing and we expect to see that continue to decrease, so we do see an endpoint where we get the efficiencies. We will see an increase approximately--I’d say it’s going to be about 50% to 60% in marketing increase in the quarter over last year, and we’ll see very strong growth.

And then on the transaction versus AOV, do you have what--

Yes, so I don’t want to give you the details and the numbers in terms of go forward, because now we’re splitting a quarter. I can tell you for year to date, we are roughly at--we’ll be about in the mid teens in transaction increases and approximately 20% in AOV.

Okay, that helps. Then as a follow-up on the marketing front, how are the ROIs and efficiencies on the marketing these days? Are the TV ads still performing to your liking? What’s working? Is there anything that isn’t working? Just some color there, I think would be helpful. Thank you.

Yes, I think right now, ROIs have been relatively stable. We’re not seeing a decrease or necessarily an increase. I think there’s two sets of--you know, there’s headwinds in pricing and competition in terms of cost, and there’s tailwinds in terms of building out our showrooms, so we expect as we go forward for the next 12 months to be looking at pretty stable ROIs based on different combinations. Dave, also I would say we’re roughly--this year, we’re roughly spending at the 12% of marketing--12% of net sales. That will possibly go up just a little bit, but we’ll talk about that in the future, but we don’t see any dramatic changes in terms of--the rates of marketing will not increase faster than the rate of sales in terms of the future as we go forward.

Okay, and then on the ROIs, them being stable, are those still consistent with the numbers you laid out, I think when you--around the timing of the IPO, in terms of--

Yes, we’re very pleased, and to put it into more detail, I think the subtlety there is that if you look at the market right now, just about everybody is advertising around those big furniture periods, right, and they’re mostly digitally advertising or the classic furniture companies are promoting a thousand dollars off, etc. Our awareness of our branded advertising has no promotion mention in it, it’s not promotional advertising at all, so what we’re really talking about is a distinction between creating brand awareness, which we believe is absolutely critical in the long run, creating a more efficient way to create brand awareness, and separating that activity from the conversion activity that is really around those key furniture buying periods and driven by digital. We will certainly continue to heavily invest our digital around those periods, but what we’re finding is that by creating brand awareness where there’s less promotional noise, we can get some pretty high ROIs year round, and in fact it makes us feel really good about next year because instead of focusing all of our media and our analysis on 14 to 18 weeks, we’re looking at 52 weeks and looking at really being subtle about how we manage our brand building aspect of our business, relative to our conversion or our promotional aspect of the business. That’s why it’s hard to understand what we’re saying and our excitement is. I think as we roll out for next year and we talk about our annual plans, it’ll be a lot clearer, but we’re seeing an always-on opportunity in brand awareness which allows us to really manage costs and manage around the competition in ways they can’t, because they’re so promotionally dependent.

Okay, that’s very helpful. Thanks for taking the questions, and good luck with the rest of the year.

Thank you.

Thank you. The next question is from the line of Alex Fuhrman with Craig Hallum. Please proceed with your question.

Great, thanks very much for taking my question. I wanted to ask about the attach rate on the Power Hub and the storage seat that you’re seeing. Those were certainly very impressive numbers. Can you give us a sense of when that really started to pick up, and have you been marketing pretty aggressively to former customers to get them to come back in and get the Power Hub? Just curious how long we should expect to see that lift in average order value.

Good question. I would expect--we have not really been spending--I would say we haven’t been doing an over aggressive marketing program with those items. We certainly market to our installed customer base, obviously via direct mail and catalogs, etc, so they’ll be aware of it, but we don’t see any reason for that attachment rate at this point to go down. Now, it’s very early, but based on what we’re seeing, we expect to build that into the business model for the next year.

Okay, that’s really helpful. Thanks. If I could just ask a question on the mechanics of the Q3 numbers here. Comparable showroom sales were up very nicely, close to 30%, which was more than the increase in showroom revenue. Can you give us just the summary on how comp store sales have been higher that showroom revenue for this quarter? Is this just the timing of when stores have entered the comp base or something like that?

Exactly, it’s all comp base. It is absolutely 100% driven by timing of the comp base. If you were to--and obviously we have, as we look at our new showroom opening run rates, they’re as strong as they’ve ever been, so we’re extremely excited about especially our new, some of our off-mall openings having extremely high run rates, so it’s primarily a shift.

Okay, thank you very much.

Thank you. We have reached the end of the question and answer session. I’ll now turn the call over to management for closing remarks.

Shawn, you want to take this?

Yes. Thanks so much for joining us today, and we appreciate all of the great questions. Once again, thanks to all the Lovesac family for your hard work, and we are very excited about fourth quarter and moving into next year and continued growth. Thank you.

Thank you. This concludes today’s conference. You may disconnect your lines at this time. Thank you for your participation.